The university, which raised in-state undergraduate tuition
5.2 percent last year as its endowment returns tumbled, will
acquire $162 million of so-called basis swaps that wager on the
difference between tax-exempt and taxable bond rates, according
to Moody’s Investors Service. It is also set to borrow about
$229 million in tax exempts this week, using some of the
proceeds to refinance floating-rate bonds and terminate other
derivatives, said Glen Klein, the school’s director of
investments and financial management.

“It’s a risk that we understand and are comfortable
taking,” said Klein regarding the basis swaps. He declined to
say how much they will pay to terminate swaps.

Michigan State, based in East Lansing, historically
“pursued an aggressive strategy” using derivatives in an
attempt to lock in low fixed rates after selling floating-rate
bonds, said Moody’s, which has a negative outlook on the credit.

Like other schools that embraced derivatives, it is
restructuring bonds and unwinding agreements that no longer
produce savings. Unlike most other tax-exempt borrowers, it is
also adding new swaps, said Andrew McKendrick, a managing
director at PFM Asset Management LLC in Philadelphia.

Debt Refinancing

Wesleyan University in Middletown, Connecticut, last month
sold $186.6 million of fixed-rate bonds as it sought to
refinance all its debt, replacing floating-rate securities
linked to derivatives, according to Moody’s. David Pesci, a
spokesman, declined comment.

Northeastern University in Boston paid $40 million to exit
$296 million of contracts earlier this year, Moody’s said in a
separate report. Michael Armini, a spokesman, didn’t return
calls.

“Anybody that’s been through the volatility of the last
three years has a natural reaction to reduce risk just in
case,” said PFM’s McKendrick, a municipal swap adviser who
isn’t working on the Michigan State financing. “Most borrowers
have looked at that and said we’re going to back off all that
risk at this time.”

Peak of Swaps

As much as $300 billion of swaps were completed in the
municipal market a year before the credit crisis, according to
estimates from the Municipal Securities Rulemaking Board.
Typically borrowers sold floating-rate bonds and in private,
unregulated agreements, exchanged payments with investment banks
to pay a fixed rate that was lower than conventional tax-exempt
rates.

Those unraveled because the direction of lending rates
reversed as the financial crisis ensued. Banks have also
increased fees they charge to serve as buyers of last resort for
tax-exempt floating-rate securities, undermining savings from
the derivatives, Michigan State’s Klein said.

Derivatives Legislation

Derivatives are based on the value of another security or
benchmarks such as stock options. They have been blamed for
aggravating the financial crisis that led to the longest
recession since the Great Depression. Wall Street banks would be
held responsible for steering municipal borrowers into
derivatives under legislation proposed by U.S. Senator Blanche
Lincoln, an Arkansas Democrat who heads the agriculture
committee.

Michigan State had 12 separate agreements tied to $476.1
million of its $535 million in long-term bonds at the end of
June, according to its annual report. The school pays fixed
annual rates ranging from 3.5 percent to 5.3 percent to
Frankfurt-based Deutsche Bank AG (DBK), Zurich-based UBS AG (UBSN), London-based Barclays Plc, (BARC) and JPMorgan.

Klein declined to specify which of the contracts may be
terminated with proceeds from its bond sale this week.
Charlotte, North Carolina-based Bank of America Corp. and
JPMorgan are underwriting the offering, according to bond
documents.

Savings Estimate

“If you look at it over a 30-year bond issue we fully
expect to realize savings” from swaps, Klein said. He said the
savings are projected to be about 50 basis points, or 0.5
percentage point, in interest costs. “It isn’t a short term
strategy.”

The university has another $430 million in such agreements
that bet on differences between short-term and long-term bond
rates, both from tax-exempt and taxable markets, according to
its annual report. Klein declined to say whether these existing
agreements have produced gains or losses. He confirmed that the
school is planning to add another $162 million of basis swaps,
“markets permitting.”

Michigan State will enter into new agreements in which it
will pay the Securities Industry and Financial Markets
Association seven-day swap index, which was 0.3 percent on April
28, according to Bloomberg data, and receive 67 percent of one-month Libor, or 0.19 percent, based on yesterday’s 0.284 percent
rate “plus a spread” according to Moody’s.

The school, which had an enrollment of 46,045 in 2007 and
ranked the 11th largest according to the U.S. Department of
Education, posted $16 million of collateral to counterparties as
of March 17 because the value of some of its agreements fell
with interest rates, according to Moody’s. It also held $10.5
million of collateral from the banks, the rating company said.

Negative Outlook

Moody’s said in an April 15 report that it is maintaining
its negative outlook on Michigan State because of “concern
about the risks embedded in the university’s debt and swaps
portfolio as well as its exposure to the economic and financial
challenges facing the state of Michigan,” which cut aid to the
school 12 percent to $318 million this year. It rates the school
Aa2, two steps below the top grade.

Laura Sander, the lead analyst at Moody’s based in Boston,
referred questions to John Cline, a New York-based spokesman,
who didn’t return calls.

Following are descriptions of pending sales of municipal
bonds in the U.S.:

METROPOLITAN WASHINGTON AIRPORT AUTHORITY, which operates
Ronald Reagan Washington National and Washington Dulles
International airports near the nation’s capital, will offer
$650 million in revenue bonds as early as next week. The
securities are part of $2.9 billion of debt the authority plans
to issue to help fund an extension of the Washington
Metropolitan Area Transit Authority’s rail system, according to
S&P. Citigroup Inc. (C) will market them to investors. The debt is
rated Baa1 by Moody’s and BBB+ by S&P, the third-lowest
investment grades. (Updated May 5)

NORTH TEXAS TOLLWAY AUTHORITY, which builds, maintains and
repairs turnpikes such as the Dallas North Tollway, plans to
offer $400 million in tax-exempt revenue bonds tomorrow.
Proceeds will go toward funding the construction and development
of 11.5 miles of State Highway 161 in Dallas County and other
capital projects, according to preliminary offering documents.
JPMorgan Chase & Co. will lead the group underwriting the
securities, rated Baa3 by Moody’s, the lowest investment grade.
(Updated May 5)

VIRGINIA’S COMMONWEALTH TRANSPORTATION BOARD, which
oversees the third-largest system of state-maintained highways
in the U.S., plans to offer $492.7 million in revenue bonds in a
competitive sale May 12. Buyers will have the option to bid for
the debt as tax-exempt or Build America Bonds. Proceeds of the
sale will go to matching certain federal highway funds and
projects on state highways and public transportation. The
securities, rated Aa1 by Moody’s and AA+ by S&P and Fitch, the
second-highest rankings, mature serially from 2011 through 2035.
(Added May 5)

LONG ISLAND POWER AUTHORITY, which provides electricity to
1.1 million customers, will issue $210 million in taxable Build
America Bonds today to fund capital needs. Underwriters led by
Morgan Stanley marketed $200 million in tax-exempts yesterday,
with four-year bonds priced to yield 2.15 percent and five-year
notes offering 2.49 percent. Citigroup will lead the
underwriting group for today’s taxable issue. Both portions are
backed by electric-system revenue and are rated A3 by Moody’s
and A- by S&P, fourth-lowest investment grade, and A by Fitch,
one level higher. (Updated May 5)

SEATTLE CITY LIGHT, a municipally owned utility that
provides power to about 1 million people, will sell about $811
million in electric revenue bonds as soon as this week to
refinance existing debt and fund capital improvements. The sale
comes in three issues, with $590 million in tax-exempts, $207.7
million in Build Americas and $13.3 million in taxable Recovery
Zone Economic Development bonds. Citigroup will lead
underwriters in marketing the securities, which are rated Aa2 by
Moody’s, third-highest, and AA- by S&P, one level lower. (Added
May 5)

SISTERS OF CHARITY OF LEAVENWORTH HEALTH SYSTEM, made up of
11 hospitals and four clinics spanning four states, will sell
about $1 billion in tax-exempt bonds as soon as this week
through the Colorado Health Facilities Authority, the Kansas
Development Finance Authority and the Montana Facilities Finance
Authority, according to S&P. Proceeds from the offering will be
used to refund prior debt issued by the authorities. The bonds
are rated AA by S&P, its third-highest grade, and one level
lower, AA-, by Fitch. JPMorgan Chase & Co. and Morgan Stanley
will lead underwriters in marketing the sale to investors.
(Added May 5)